Rumblings from Taiwan

January 10, 2001

By Mark T. Fung

WASHINGTON

There is a Chinese folk custom that all debts should be settled before the Lunar New Year. In this case, the Year of the Snake begins on Jan. 24.

This custom of settling debts may prove difficult for Taiwan in the months ahead: An economic calamity may be just over the horizon. That, in turn, would have an impact on Taiwan's broader, and explosive, relationship with the mainland, which, in turn, affects strategic interests of the United States.

The economic rumblings in Taiwan are heard only distantly here in the US, but what is coming may be nothing short of an economic avalanche. This grim prospect is a result of a number of factors, including political instability and lack of confidence in the new president, Chen Shui-bian. President Chen is perceived as a weak leader, a result of his performance as well as his lack of mandate (he won just 39 percent of the vote last March). Recent rumors of Chen's extramarital affairs also don't help matters. And most recently, Taiwan's leading economic indicators have dipped to an 18-month low that presages further decline.

An economic crisis in Taiwan - which has already invested more than $40 billion in China - would shut off the capital spigot to the mainland. Without the presumptive 8 percent rate of growth in China to maintain stability on the mainland, this could lead to an increase in unemployment and even greater social rifts between the urban and rural classes there. Domestic instability could create a "wag the dog" temptation, in which China's leaders would generate a military crisis over Taiwan to distract the public from domestic problems.

Economic vicissitudes are not new to Taiwan, but this looming financial crisis could be of a magnitude analogous to the US savings-and-loan debacle of the 1980s. Put simply, overvalued shares of stock have been used as collateral to borrow money from banks. Zealous lending institutions earn large fees for originating loans, and thus begins the vicious cycle that is tantamount to a pervasive Ponzi scheme in Taiwan; there is no strong financial underpinning to these loans.

For the past three years, Taiwan's economic vitality was really a response to the ostensible Teflon coating enshrouding it. Disasters both natural and financial in Asia seemed to glide off Taiwan. When semiconductor production was temporarily halted as a result of an earthquake on the island on Sept. 21, 1999, Taiwan was bruised, but nothing more. When a Singapore Airlines plane crashed in Taipei during take-off last October, however, it was widely seen by Taiwanese as symbolic of the bad news coming. Last-ditch government remedies such as tax breaks are showing little effect.

As the Taiwan stock market goes south - it has lost about 50 percent of its value since last February - so goes the economy. Margins have been called in without sufficient valuation. This triggers panic selling of fundamentally sound assets for the sake of meeting bank loan and margin calls. And as principles of economics would dictate, too many sellers and not enough buyers depress prices further. From the financial sector, to real estate, to high technology, all these are key elements of the economic dynamism that is Taiwan. But success is a double-edged sword; it breeds overconfidence and carelessness.

Trepidation among investors about the future growth potential of Taiwan and the ability of industry to expand across the strait into China is a primary factor behind investor confidence plummeting. The new finance minister, Yen Ching-chang, has deepened the pessimism by discouraging investments on the mainland that could potentially enhance China's leverage over Taiwan. Taiwan's vast reserves of foreign exchange can be tapped once, perhaps twice, in exigent times. But these reserves, which are at an 11-month low and have decreased $825 million in the last few months alone, must be used sparingly.

Critics in Taiwan of expanded economic relations with China argue this will create a dependency on Taipei's part and that will give Beijing greater political leverage. But the truth of the matter is that it will create interdependency, a two-way street. As future members of the World Trade Organization, both China and Taiwan will be governed by the trading body's rules. Ultimately, capital flows to areas with the greatest returns; China is offering higher-than-average returns.

If Taiwan investors want a sanctuary, they can always buy 10-year US Treasury bonds, which are now yielding about 5 percent. However, Taiwan investors prefer the similarity of culture that China provides as well as the higher returns that an investment in China enjoys. And on the eve of China's accession to the WTO, and Taiwan's soon thereafter, more trade is the key to more stability.

An economic crisis could become a strategic crisis. China could try to exploit Taiwan's weakness by stepping up pressures in cross-strait talks; the US might then come under pressure to involve itself in the cross-strait negotiation in order to head off a conflict. Alternatively, Beijing could sit back and do nothing to help - which could stimulate anti-China resentment among the people on Taiwan. The strategists can point to a variety of scenarios, most of them dangerous.

Mark T. Fung is assistant director and research fellow in China studies at The Nixon Center in Washington.